Are You Ready for Retirement: The numbers (Part 2)

The hardest part about planning for retirement is being able to tell the future. It just so happens that we have no idea what is in store for us. For all you know there might be some serious inflation in the next 10 years causing your retirement funds to soar through the roof, followed by going significantly conservative just before the cycle goes sour leaving you with a hefty sum of money. On the other hand, it could be the exact opposite; you have more money saved today than the day you planned on retiring.

In either case, you mustn’t be illogical with planning in terms of numbers, so the big question is how much should be saved? Well, that depends on your expected lifestyle during retirement. Do you plan on buying a new, more expensive home, or downsize and keep some equity? Are you going to be purchasing vehicles and going on luxurious vacations? These types of questions must be answered, and once you figure them out you can set yourself up with a great goal.

Here’s how to start; define the current lifestyle you “think” you want to have for retirement and determine what that would cost today. Let’s say you no longer want a mortgage, but you still want to pay some college tuition for grandchildren, and spend about $10-20k a year on gifts and vacations. Of course, you still must include medical expenses because Medicare isn’t free, despite what the general population believes, and you still have to pay for property tax. Let’s just say that your “premium lifestyle” is going to cost you $80k per year in today’s dollars.

Now, let’s breakdown your “premium lifestyle” so we can determine your objective:

  • Lifestyle = $80k per year
  • Retirement age = 65
  • Expected age of death = 95 (yes, you must solve for this as morbid and harsh as that sounds)
  • Life expectancy after retirement = 30 (age of death – retirement age)
  • Total expected need $80k times 30 years = $2.4 Million

Well, there we have it, the need is about $2.4 Million dollars…But wait, that’s ridiculous and not even close to true. We can make interest on your money as well, plus you’ll likely receive a Social Security benefit. Thus, we can subtract another $20k from our yearly need, putting you at $60k a year, and a new lump sum goal of about $1.8 Million. Of course, with downsizing your home, you might find yourself with some extra cash in the bank as well, but let’s just assume you didn’t do that.

Now the big question, how will you save up $1.8 Million dollars?

Let me spare you some Calculus and do the math given the following assumptions:

  • Start working/saving at age 25 when you make $60,000 annually
  • Have an average merit increase of 2% per year
  • Save a total 18% of your annual income (with or without company match)
  • Assume a 5% real rate of return (money earned adjusted for inflation)

If you can do this, you will have your $1.8 Million at age 65.

Now, saving 18% is EXTREMELY aggressive! To start off it might sound very challenging as you would be saving about $11k for your first year at age 25. However, it is actually easier than it sounds in the LONG RUN when, at age 64, you are only having to tuck away $23k to retirement of your $127k annual income.

The big takeaway is that you MUST GET STARTED while age is on your side. Trust me on this math, but if you waited until age 35 to deploy this exact same savings plan, you’d only have just over $1 Million saved in cash at age 65.

With the magic recipe being to use the advantage of time, I want to make a couple comparisons to help highlight how this works: (samples assume a 5% real rate of return)

  • A constant income of $63k per year with 12% contribution for 40 years will net you the same amount of total savings as an income of $115k per year with 12% contribution for 30 years
  • A constant $70k income for 40 years with 12% contribution will net you about $1 Million but doing so for 30 years only nets you about $582k.
    • 10 less years almost cuts your savings in half!

Lastly, if you are not convinced that time is the answer then let’s just solve a very simple problem. How can you save up $1 Million if you only make $70,000 per year for the rest of your working career? (again, assuming a 5% real rate of return)

William Fleming, Contribution Calculator

Photo by Ben Turnbull on Unsplash

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